Annaly Capital Mangement: Strengths, Weaknesses, Opportunities, Threats

Leveraged mortgage-backed securities -- four words associated with the financial crisis, housing crash, and the recession. Unless you're an investor in Annaly Capital Management (NYSE: NLY  ) . Then those four words mean a big, fat dividend payout every quarter.

A SWOT analysis -- a look at strengths, weaknesses, opportunities, and threats -- will help assess whether Annaly's outsized dividends can continue or if investors should be lowering expectations a bit.

Strengths:

  • Nearly 16% dividend yield.
  • By limiting investments to U.S. government-backed debt, Annaly nearly eliminates credit risk.

Weaknesses:

  • Annaly's interest rate spreads have been shrinking since the end of 2009. If that trend continues, the dividend isn't sustainable at current levels.
  • REIT dividend payouts are required to be at least 90% of taxable income. As a result, the dividend stream can be somewhat unpredictable, and the company doesn't have the ability to retain earnings for growth.
  • Leverage doesn't provide much cushion for errors or unfavorable markets.

Opportunities:

Short-term rates near zero set up a near-perfect business environment for Annaly and other mortgage REITs. The Motley Fool's stock screener lists 18 stocks with dividend yields higher than 15%. One-third of them focus on real estate debt, including the five listed below.

Company

Dividend Yield (TTM)

Payout Ratio

American Capital Agency (Nasdaq: AGNC  )

19.9%

108%

Resource Capital Corporation (NYSE: RSO  )

16.9%

81%

Chimera Investment (NYSE: CIM  )

16.2%

88%

Annaly Capital Management

15.8%

146%

Hatteras Financial (NYSE: HTS  )

15.8%

121%

Source: Yahoo! Finance. TTM = trailing 12 months.

Threats:

  • A rise in short-term rates would increase borrowing costs and squeeze margins.
  • Sudden moves in mortgage rates could reduce the interest spread. With falling rates, high-yielding mortgages get refinanced pulling that income stream. With rising rates, the market value of existing paper falls, creating unrealized losses and reducing the collateral value available for Annaly's repurchase agreement financing.
  • At some point, the administration or Congress will focus on reforms for the mortgage industry. New regulations or changes to guarantee policies could fundamentally change Annaly's business model.

As long as short-term rates hold at rock bottom and the U.S. government keeps backing its agencies Fannie Mae and Freddie Mac, Annaly may as well have a license to print money. However, investors shouldn't count on a 16% yield continuing. The high payout ratio and declining interest rate spread are warnings that the yields that Annaly and some of its peers churn out are likely to pull back from monster to just high.

What parts of Annaly's SWOT need more detail? Weigh in with a comment below.

Related Foolishness:

Fool contributor Russ Krull owns stock in Hatteras Financial, but no other companies mentioned. The Fool has a disclosure policy that pays big dividends.


Read/Post Comments (5) | Recommend This Article (16)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 09, 2010, at 1:48 PM, revrurik wrote:

    The Motley Fool has been hammering and yammering on NLY a lot lately, shaking the tree and making people fret. Why, I wonder? Yes, it has a stellar dividend. And yes, "Annaly's interest rate spreads have been shrinking since the end of 2009. If that trend continues, the dividend isn't sustainable at current levels." Gosh, does that mean that the dividend might go down to 12%? 10% 8%? .... all of which are still incredible. And guys, if things start going south for Annaly, I think we all know enough to do one simple thing: sell.... after we've already reaped the benefits of the currently stellar dividend.

  • Report this Comment On August 09, 2010, at 2:14 PM, cmolinel wrote:

    Aproximately, a reduction of half a point in the spread will mean a drop from 14% to 10% in NLY roe.

    Of course stock price will fall significantly.

    However, for the time being, I continue long on NLY.

  • Report this Comment On August 09, 2010, at 9:29 PM, loucanoe wrote:

    There is one cushion to falling spreads that most commentators appear to miss--the company is leveraged about 6 to 1 but say in their filings that they would be comfortable at 8 or 9 to 1. A move to 7 to 1 would more than offset the 10-14% decline in earnings mentioned in the previous post. Disclosure--I own the stock.

  • Report this Comment On August 13, 2010, at 4:59 PM, SF66 wrote:

    NLY Hedges interest rate risks by balancing longer term fixed rate mortgages with shorter term ARMs and swaps.

  • Report this Comment On August 31, 2010, at 10:25 AM, stmichaeldefends wrote:

    The way to handle REITs: Of course, these dividends are not going to go on if there is a squeeze in the mortgage spreads. But there is a formula I use to anticipate these drops. As a mainly income producing investor, when i look at one of these REITS for purchase I immediately cut the divididend in half for financial income planning. I don't like disappointments with dividends. And if the dividend doesn't drop that much, it's so much gravy. Would you really be all that upset if American Capital Agency only returned you 10% instead of 19.9% if they cut the dividend in half?. Look around, other than some high-yield bonds (cleaned up from the title junk bonds of late) and ETF's, some of which are either returning capital to maintain their dividend or cutting them, you're not going to find the rates that are in a REIT. The second prong is to be gradual in your purchases of REITS and cost average. If you're planning to buy a 100 shares buy 25 quarterly. Forget about the commission cost if you have a discount broker that charges about $9.00. The cost is only 36 cents for 25, 18 cents a share for 50 shares. Just cost average on these. Also you will want to divesify in the sector. Talk about risk, it's everywhere. With this volatile makret, every time I have bought a stock most of them go down an average of 3% or much worse. I've bought so- called highly touted stocks like Abbott Labs. Bought it Jan. 7, with commission I paid $54.76. As I write this it's selling for $49.14, a drop of $5.62 or 10.25%!. I could go on as you could,too, with these horror stories. With this kind of lunacy (there is absolutely nothing wrong with ABT techniccally, it has international market exposure, sppsedly afir wall for our lousy US economy, still, it wen down), I don't see how you can go wrong on the REITS despite all these scare tactics from the columnists if you follow my four plants

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